Question

1. Warren Lynch at CompU has calculated the cash flows for the advertising campaign, and now has to decide whether the ad campaign will generate more cash flows than its cost. The cash flows for the campaign are as follows. CompU’s cost of capital is 9%.

Initial Investment: $110,000

Operating Cash Flows by year:

Year                 Cash Flows

1                      $35,000

2                      $39,800

3                      $34,600

4                      $31,800

5                      $31,800

1. Calculate the payback period of the ad campaign.

2. Calculate the net present value of the campaign.

3. Calculate the internal rate of return of the campaign. Should the campaign be accepted?

2. CellU, a subsidiary of CompU, is looking to replace one of the machines they use to manufacture cell phones with a new, more efficient model. The incremental cash flows of the new machine are as follows. CellU’s cost of capital is 11%.

Initial Investment: $12,190

Operating Cash Flows by year:

Year                 Cash Flows

1                      $4,974

2                      $5,760

3                      $4,320

1. Calculate the payback period of the new machine.

2. Calculate the net present value of the new machine.

3. Calculate the internal rate of return of the new machine. Should the machine be accepted?

Answer 1

Q1
Year	Cash flows	Cumulative CF
0	-110000	-110000
1	35000	-75000
2	39800	-35200
3	34600	-600
4	31800	31200
5	31800	63000
Payback	3.02
NPV	25522.24
IRR	17.84%

The machine should be accepted since NPV is positive and IRR>Cost of capital

Q2
Year	Cash flows	Cumulative CF
0	-12190	-12190
1	4974	-7216
2	5760	-1456
3	4320	2864
Payback	2.34
NPV	124.77
IRR	11.60%

The machine should be accepted since NPV is positive and IRR>Cost of capital

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